Waived off loan means a situation wherein the lender voluntarily relieves a borrower of the obligation or liability to repay loan. This means that there is a surplus of cash/money in the hands of borrower and thus, a receipt in the hands of the borrower/assessee. Now the question is whether such waived off loan shall be income and be subject to taxation.
Law is well settled that an implied power to tax does not exist in Indian tax regime. Several judicial Pronouncements have dealt with the subject matter. The Hon’ble Apex Court in LSE Securities Limited v. Commissioner 2013 (29) S.T.R. 591 has settled the principle of taxation:
The issue in relation to taxability of waiver of loans revolves in the ambiguity in interpretation of the provisions of Section 41(1) and Section 28 (iv). The question that arises for consideration is that whether loan is a trading liability and waiver of the same will be chargeable to tax under the provisions of Section 41(1) and further waiver of loan being a cash receipt, whether Section 28(iv) will be applicable or not.
The issue is whether waiver of loan is taxable as a remission of liability under Section 41(1) or taxable as a perquisite under Section 28(iv) of the Income Tax Act.
This article tries to analyse the legal standpoint with respect to the issues under consideration.
1. Whether waiver of loan be considered as a remission of liability and therefore taxable under Section 41(1)?
Before considering whether waiver of loan is a remission of liability or not and whether section 41(1) shall be applicable, we shall first understand the situation wherein the aforesaid provision is applicable. The Hon’ble Supreme Court in CCIT Vs. Kesaria Tea Co. Ltd (2002) 3 SCC 684, held as follows:
“In order to apply Section 41(1) in the context of the facts obtaining in the present case, the following points are to be kept in view : (1) In the course of assessment for an earlier year, allowance or deduction has been made in respect of trading liability incurred by the assessee; (2) Subsequently, a benefit is obtained in respect of such trading liability by way of remission or cessation thereof during the year in which such event occurred; (3) in that situation the value of benefit accruing to the assessee is deemed to be the profit and gains of business which otherwise would not be his income; and (4) such value of benefit is made chargeable to income tax as the income of the previous year wherein such benefit was obtained.”
The first and foremost requirement for application of section 41 (1) is that deduction must have been availed by the assessee. The Hon’ble Madras High Court in CIT Vs. Rayala Corporation (P) Ltd. has held that, “thus unless the amount had been allowed as a deduction in the earlier years, the question of invoking Section 41(1) does not arise.”
In view of the above mentioned case laws, two scenario arise:
One where no deduction has been claimed with respect to loan in the year when the loan was availed: Under this circumstance the legal stand point is clear and the waived off amount shall not be subject matter of taxation and
Second deduction has been claimed by the assessee with respect to loan in the year when loan was availed, now this issue is required to be examined. To understand the taxability of waived off loan the following aspects is required to be considered:
1. Purpose/ Nature of the loan
2. Accounting treatment of the waived amount
3. Purpose/ Nature of loan: Loan can be availed by the borrower for various reasons such as to repay some existing loan, purchase of capital asset, expansion of business etc. The purpose for which loan amount was utilized largely determines whether such waiver of loan will amount to remission of liability or not and hence subject matter of taxation as profit chargeable to tax under section 41(1) of the Act. The issue has discussed in various case laws, the Hon’ble Delhi High Court in Logitronics (F) Ltd. Vs. CIT & ANR. 2011 SCC OnLine Del 896, (Delhi High Court), has held that
“waiver of loan may be considered as income only when the loan is taken for trading purposes and not for acquisition of a capital asset and is also treated as such from the beginning in the books of accounts. It was also held, in the aforesaid case that where the loans that were borrowed by the assessee were a source of funds employed in its business of financing, it could not be said that the business of the assessee was to borrow money by way of loans, more so, when the tribunal had arrived at a finding of fact that the amount of loan was not used in financing the business. Therefore, the outstanding loan written back by the assessee could not be treated as its income. Whether the waiver of a loan is taxable as income or not depends on the purpose for which the loan was taken. If the loan was taken for acquiring a capital asset, the waiver thereof would not amount to any income eligible to tax u/s 28(iv) or 41(1).”
Furthermore, in Rollatainers Ltd vs. CIT 2011 SCC OnLine Del 3660, it was held that:
“Thus, the loans were for the circulating capital and not the fixed capital. In any case, even if s. 28(iv) is not applicable, s. 41(1) is clearly applicable.”
In light of the aforesaid judgements, it can be said that waiver of loan shall be taxable when it has been utilized for the purpose of trading activities of the business and when it has been availed for the purpose of acquisition of capital asset or say activities which does not constitute to be trading activity of the business, then such waived off amount shall not be taxable in the hands of the assessee.
1. Accounting treatment of the waived amount: Accounting entries is considered as one of the factors while determining the income from business and profession. When after the waiver of the loan amount, the assessee starts to treat such loan as his/her own money and starts reflecting it in the P&L Account, such receipt changes its nature from liability and takes the form of income of the assessee for the purpose of taxation u/s 41 (1) of the Act.
The Hon’ble Supreme Court while analysing the accounting treatment of waived off loan has held in CIT v. T.V. Sundaram Iyengar & Songs Ltd. (1996) 222 ITR 344 that:
“The principle laid down by Atkinson, J. applies in full force to the facts if this case. If a common-sense view if the matter is taken, the assessee; because of the trading operation, had become richer by the amount which if transferred to its profit and loss account. The moneys had arisen out if ordinary trading transactions. Although the amounts received originally was not of income nature, the amounts remained with the assessee for a long period unclaimed by the trade parties…
… In other words, the principle appears to be that of an amount is received in course of trading transaction, even though it is not taxable in the year of receipt as being of revenue character, the amount changes its character when the amount becomes the assessee’s won money because of limitation or by any other statutory or contractual right. When such a thing happens, common sense demands that the amount should be treated as income of the assessee.
In the present case, the money was received by the assessee in course of carrying on his business. Although it was treated as deposit and was of capital nature at the point of time it was received, by influx of time the money had become the assessee’s own money. What remains after adjustment of the deposits had not been claimed by the customers. The claims of the customers have become barred by limitation. The assessee itself has treated the money as its own money and taken the amount in its profit and loss account. There is no explanation from the assessee why the surplus money was taken to its profit and loss account even if it was somebody else’s money.”
From standpoint of the precedence set by the Apex Court of the country it has been settled that if the waived of loan takes nature of the money of the assessee and increases the profit of the assessee, then such waived off loan will form part of income from business and profession and shall be subject to taxation.
Further, in a case wherein the waiver of loan amount was transferred to capital reserve account of the balance sheet by the assessee, it was observed by the Commissioner of Income Tax (Appeals) that the remission of the principal amount of loan did not amount to income under Section 41 (1) nor under Section 28 (iv) nor under Section 2(24) of the Income Tax Act, 1961. The Delhi High Court upheld the view of the CIT in holding that remission of principal amount does not amount to income in CIT v. Tosha International 2008 SCC OnLine Del 1547 and further upheld that:
“As per our considered view, for attracting the provisions of Section 41 (1), the first requisite condition to be satisfied is that the assessee should have got deduction or benefit of allowance in respect of loss, expenditure or trading liability incurred by it and subsequently during any previous year, the assessee should have received any amount in respect of such loss, expenditure or trading liability by way of remission or cessation thereof. The remission would become income only if the assessee has claimed deduction in respect of expenditure or trading liability…
…In the instant case, the assessee has not got any deduction on account of acquisition of capital assets as the same has been reflected in the balance sheet and not in the P&L account, and also the remission of the principal amount of loan so obtained from the bank and financial institution had not been claimed as expenditure or trading liability in any of the earlier previous year.”
Thus, to determine whether waiver of loan shall be taxable or not u/s 41(1) of the Act it is very essential to the accounting treatment of such an amount. If the assessee shows such an amount to be his own money, then such amount shall be subject to taxation. Further where it does not lead to profit of the assessee, then such waived off loan shall not be subject matter of taxation as per section 41(1) of the Act.
2. Whether waiver of loan be considered as a perquisite under Section 28(iv) of the Income Tax Act.
As per the provisions of section 28(iv), the income which can be taxed under the said provision must be arising from business and such benefit or pre-requisite should be in a form other than money. Whether waiver of loan amounts to benefit or prerequisite in form other money arising out of business has been discussed by various courts, the Hon’ble Supreme Court while upholding the decision of the Bombay High Court in CIT v. Mahindra & Mahindra Ltd. (2018) 16 SCC 79 has held that:
“the loan amount was received as cash receipt due to the waiver of loan, therefore, the very first condition of S. 28(iv) i.e, that any benefit or perquisite arising from the business shall be in the form of benefit or perquisite other than in the shape of money, was not satisfied Therefore, the said amount could not be taxed under the provisions of S.28 (iv).”
Concludingly, it has been settled by the Apex Court of the country that waived off loan is as a receipt and it could not be considered as a prerequisite for the purpose of section 28(iv) of the Act.
Furthermore, as far as section 41 (1) of the Act is considered, if the assessee has not availed deduction for the loan so availed, the waiver of loan will not under any circumstance attract the provisions of section 41 (1). But the situation where deduction has been availed in order to avoid availment of double benefit by the assessee, the waived amount will be subject to tax depending upon the nature of loan and its accounting treatment.
It has been well settled by various judgements that waived off loan is taxable when loan is utilized for business or trading activity i.e., for the purpose of earning profit. Also, it was upheld in Encorp E-services Ltd. V. ACIT 2016 SCC OnLine ITAT 2879 that:
“In the aforesaid circumstances, the issue was to be restored to the file of the Assessing Officer for his fresh adjudication with a direction to the assessee to furnish all the details and particulars of loan, and the purpose for which the loan taken from bank was utilized. All these information was within the control and specific knowledge of the assessee and, therefore, it would be the duty of the assessee to prove and establish that the amount of loan taken from the bank was utilized for the purpose of acquiring capital assets. If on enquiry and verification, it transpired that the assessee had utilized the loan for the purpose of its business activity or trading activity, the amount of loan to the extent it had been waived by the bank, would be deemed to be the assessee’s income chargeable to tax.”
Thus, it is clear that the assessee needs to prove to the department that the nature of loan was not as such that it was used to carry on any trading activity. Until and unless the facts are not settled with respect to the purpose for which loan was availed/utilized it cannot be assessed whether the waived off loan shall be subject to taxation as profit from business u/s 41 (1) of the Act or not. This leads to another question i.e., when can a loan be considered to form part of trading activity of any business.
To understand whether the loan is part of trading activity of business/ profession, the High Court of Madras in the case of Iskraemeco Seahorse Ltd. Vs. The Commissioner of Income Tax 2010 SCC OnLine Mad 5901 held as follows:
“22. In the present case on hand, admittedly the Assessee was not trading in money transactions. A grant of loan by a Bank cannot be termed as a trading transaction and it cannot also be construed in the course of business.”
So, if the business/profession of the assessee is not in money transaction it will be not be assumed that the loan was availed for trading purpose. In a nutshell what is required to be looked into is the primary activity of any business/profession.
Concludingly, by plethora of judgements, it has been settled that if loan has been utilized for any ancillary activity of any business/profession or for acquisition of capital asset and further when the waived off loan is not treated as assessee’s money. Such waived off loan amount would not attract the provision of section 41 (1) of the Income Tax Act. In any other situations, the facts and circumstances will have to be closely examined to determine whether such waived off loan amounts to profit from business and consequently taxable u/s 41(1) of the Income Tax Act.
[Authored by Anjali Jain, Associate Advocate, Rajesh Kumar and Associates. The author can be contacted on [email protected]]